Question

​Long-term investment​ decision, payback method Personal Finance Problem: Bill Williams has the opportunity to invest in project A that costs $6,800

today and promises to pay $2,300​, $2,600​, $2,600​, $1,900

and $1,800 over the next 5 years. ​ Or, Bill can invest $6,800 in project B that promises to pay $1,300​, $1,300​, $1,300​, $3,600 and $4,000

over the next 5 years. (​Hint: For mixed stream cash​ inflows, calculate cumulative cash inflows on a​ year-to-year basis until the initial investment is

recovered.​)

a.  How long will it take for Bill to recoup his initial investment in project​ A?

b.  How long will it take for Bill to recoup his initial investment in project​ B?

c.  Using the payback​ period, which project should Bill​ choose?

d.  Do you see any problems with his​ choice?

Answer 1

Payback period is the time period in which the initial investment in recovered
Project A
Year	Cash Flows	Cumulative Cash flows
0	-6800	-6800
1	2300	-4500
2	2600	-1900
3	2600	700
4	1900	2600
5	1800	4400
Payback period = 2 + 1900/2600 = 2.73 years
Project B
Year	Cash Flows	Cumulative Cash flows
0	-6800	-6800
1	1300	-5500
2	1300	-4200
3	1300	-2900
4	3600	700
5	4000	4700
Payback period = 3 + 2900/3600 = 3.81 years
Use Project A, since lower payback period
Yes, since the payback period does not consider cash flows after payback period